Infrastructure Project Financing

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Author : meghnabhaskar
Published on : July 05, 2011

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Meghna Bhaskar Student BALLB

Infrastructure Project Financing
A special reference

Development of infrastructure is one of the most important aspects for economic growth of any country. Investors are likely to put their capital only in those countries and projects where the infrastructure is well developed.

Since the reform process began in 1991, and with the removal of the rigid licensing policy and various restrictions in industries in India, it was realized that the infrastructure sector also must be opened to private operators to meet the increasing investment needs of the country. Moreover the Government also realized that alternative financing mechanisms had to be developed to meet these needs. Thus development of infrastructure has become the central theme of the Government of India’s 11th Five Year Plan (2007-2012).

The availability of infrastructure facilities is a necessity for the overall development of our country. Today, there is a need to focus on enhancing the quantity as well as improving the quality of infrastructure services provided in India. The financing of infrastructure represents a major opportunity and challenge in India as the present scale of infrastructure development which is a result of traditional methods of financing infrastructure projects are no longer sufficient.

Project finance refers to the long term financing of infrastructure and industrial projects based on the projected cash flows of the project rather than the balance sheets of the project sponsors. The term "project finance" is generally used to refer to a non recourse or limited recourse financing structure in which debt, equity, and credit enhancement are combined for the construction and operation of a particular facility in a capital-intensive industry, in which lenders base credit appraisals on the projected revenues from the operation of the facility, rather than the general assets or the credit of the sponsor of the facility, and rely on the assets of the facility, including any revenue-producing contracts and other cash flow generated by the facility, as collateral for the debt.

Therefore, in project financing the debt terms are not based on the sponsor's credit support or on the value of the physical assets of the project. Rather it is based on project performance, both technical and economic.

In contrast to an ordinary borrowing for a new project situation, in a project financing the financier usually has little or no recourse to the non-project assets of the borrower or the sponsors of the project. Thus, the credit risk associated with the borrower is not as important as in an ordinary loan transaction; what are most important are the identification, analysis, allocation and management of every risk associated with the project.

The salient features of project finance are as follows:
The lenders finance the project looking at the creditworthiness of the project, not the creditworthiness of the borrowing party. The repayment of the loans is made from the earnings of the project.
2. Project financing is also known as “limited recourse” financing as the borrower has a limited liability. The security taken by the lenders is largely confined to the project assets.

In a no recourse or limited recourse project financing, the risks for a financier are great. Since the loan can only be repaid when the project is operational, if a major part of the project fails, the financiers are likely to lose a substantial amount of money. The assets that remain are usually highly specialized and possibly in a remote location. If saleable, they may have little value outside the project.

The minimization of such risks involves a three step process. The first step requires the identification and analysis of all the risks that may bear upon the project. The second step is the allocation of those risks among the parties. The last step involves the creation of mechanisms to manage the risks. If a risk to the financiers cannot be minimised, the financiers will need to build it into the interest rate margin for the loan.

However, the problem of supply and demand brings an obstacle. While the demand for infrastructure investment is enormous, our economy has failed to attract a supply of private investment in infrastructure projects.

This lack of investment ventures in building adequate infrastructure can be attributed to weak tariff regulation, reluctance in honouring concession commitments, inconsistent enforcement of laws, corruption, poor governance practices, lack of availability of long-term local currency financing at fixed interest rates, weak accounting and disclosure norms, and weak securities legislation.

Realizing the importance of infrastructure as the backbone of India’s economy, India has opened up this sector to private sector participation and foreign investment. As Infrastructure requirements for developing countries like India are massive, funding for such projects is a problem for the Government and it was exactly for this reason that infrastructure sector in India has been thrown open to private sector and foreign investment.

Project financing structures in India are generally no different to those prevailing in other countries. Foreign sponsors may enter into joint venture agreements with an Indian Partner to form a Special Purpose Vehicle (SPV) which executes the project. The SPV may then enter into a concession agreement with an Indian Government entity; construction and operating agreements with various contractors; and financing agreements with lenders.

Much of the foreign investment in infrastructure has been by way of equity. The roads sector has attracted many international companies like Atlantia of Italy, Isolux Corsan of Spain and John Lang of the UK. Singapore's Sembcorp recently concluded a joint venture

agreement with an Indian infrastructure company to set up a 1,320 MW power plant at Krishnapatnam in the state of Andhra Pradesh.

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